S&P's new gauge for Japanese banks

'Survivability' concept first used for Latin America lenders

By

BillClifford

TOKYO (CBS.MW) -- The health of Japanese banks has declined so dramatically that Standard & Poor's, the international credit rating agency, said Monday it will use risk criteria to assess the lenders' "survivability" that it originally had applied to basket-case Latin American financial institutions.

The development came as Prime Minister Junichiro Koizumi made a speech to parliament promising to "normalize" Japan's bad-loan mess, already more than a decade in the making, in the fiscal year ending March 2005.

"My determination to push through reforms will not waver," said Koizumi, who has had swallow several snap polls showing a collapse in his approval ratings since he fired his popular foreign minister last week. The Asahi newspaper's poll put public support at 49 percent from 72 percent in a similar survey it conducted last month.

Opposition parties responded with a symbolic no-confidence motion, while investors, more influentially, dumped Japanese stocks.

The banking sector sub-index slid 2.2 percent to an 18-year low, as shares of two of Japan's megabanks -- Mizuho Holdings and Mitsubishi Tokyo Financial Group -- hit lifetime lows in intraday trading and two others almost did.

A swamp in full measure

"The introduction of bank survivability assessments," S&P said, "has been prompted by the increasingly dire financial condition of essentially all Japanese system banks, with estimates of problem loans now far exceeding the banks' aggregate capital base."

Problem loans in the strictest sense are described as non-performing, meaning banks know borrowers won't pay them back. Japan's Financial Services Agency said Friday that bad loans at 136 Japanese banks totaled 36.8 trillion yen ($276.4 billion) at the end of September, up 3.1 trillion yen from the end of last March.

S&P and other private sector analysts believe this understates the magnitude of the bad-loan swamp. Japan's deflation-battered economy is pushing more and more delinquent corporate borrowers to the edge of bankruptcy every day, making it necessary to define problem loans more broadly, as loans that require attention as well as pure non-performing loans.

S&P explained that bank survivability assessments, which are distinct from credit ratings, allow investors to recognize that governments and financial regulators have incentives to keep key money-center banks running "in times of financial system stress or incipient insolvency."

Such assessments are opinions "regarding the likelihood that a bank will remain in business performing basic banking functions (such as basic deposit and disbursement services), regardless of whether it is solvent, or whether it is meeting all of its financial commitments on a timely basis."

S&P said it will use four criteria to assess whether a Japanese institution is eligible for, and to what degree, a survivability rating: the amount and type of a bank's liquidity; market share and ownership structure (public or private); financial strength relative to large rivals (i.e., a bank perceived to benefit from a flight-to-quality in the event of a systemic crisis would be given a higher survivability rating than financially weaker banks); historical Japanese policy toward bank workouts and the likelihood of official support. See the press release.

Historical crossroads

Many smaller Japanese banks and a few large ones have failed. Indeed, two of Japan's three long-term credit banks in recent years have been nationalized and sold to private investors who operate them today as Shinsei Bank and Aozora Bank. The third, Industrial Bank of Japan, has merged with two large commercial lenders to form Mizuho Holdings, the world's largest bank in terms of assets.

Generally, Tokyo has sought to preserve troubled banks' operations, even in instances of their defaulting on debt instruments. But S&P said it expects "the government will be more circumspect about bailing out failed banks."

Starting April 1, the government will lift blanket guarantees on insuring time deposits of more than 10 million yen ($75,000), which some analysts have said could threaten runs on smaller banks and credit unions, perhaps tipping them into insolvency. Others believe savers will calmly switch funds into deposits that will still be protected for another year.

Whatever the case, S&P said a survivability assessment should not be interpreted to indicate the risk of loss on general deposits. "A failed bank may well be allowed to default on certain financial obligations, including certificates of deposit, and may even be required to impose certain limited withdrawal conditions on retailer deposits, while also being encouraged to perform essential administrative and servicing functions that are deemed critical to the integrity of the banking system and the economy," it said.

It was to help investors differentiate between a bank's operating risks tied to future transactions from default risk in Latin America, where lenders were choking on the 1980s debt crisis, that S&P first had introduced the concept of bank survivability assessments.

Yet Japan's situation, with all its woeful banks, differs from Latin America in at least one important respect. Here, the government has more monetary reserves (about 1.4 trillion yen) than any other on the planet, thanks to years of yawning trade surpluses and structural incentives for Japanese to save rather than spend.

A crisis or not?

That's a huge cushion to soften a banking crisis, if one erupts, although it's hard to predict if the asset pile could also help stem a simultaneous meltdown in Tokyo markets.

But even when the assets just sit there, they influence policy. Princeton scholar Kent Calder, who served in Tokyo as adviser to U.S. ambassadors Walter Mondale and Tom Foley during the Clinton administration, says that Japan's position as a net creditor to the global economy "insulates it from international pressure" and acts as a constraint on resolving the bad-loan crisis. See related commentary.

Takashi Imai, head of the blue-chip business lobby Keidanren, told a press conference Monday: "I don't think a financial crisis will originate from Japan, but I think it would be good to inject public funds as part of plan to prevent (such a crisis)." Previously, Imai had said the injection of taxpayers' money to recapitalize banks was a step that "could be considered, if necessary."

In Tokyo trading Monday, the Nikkei 225 fell and the broader Topix sank to a fresh 17-year low. The banking sub-index shed 2.2 percent to 177.16, its lowest close since Nov. 1, 1983. See Asia Markets.

Shares of Mizuho (8305) tumbled 6.9 percent to close at 203,000 yen, after having hit a lifetime low of 202,000 yen. Mizuho is the main creditor bank for a trio of general contractors -- Hazama, Sato Kogyo and Tobishima -- whose shares were all trading below 30 yen (22 cents) each.

Shares of Sumitomo Mitsui Banking Corp.
SMBJF
(8318), Japan's No. 2 bank and the second most actively traded share overall, fell 4.3 percent, or 19 yen, to close at 427. At one stage it had sagged as low as 423, a trough last seen in January 1984.

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